Decoding the EU Sustainability Taxonomy: What’s at Stake?
The European Union has set ambitious goals to make Europe the world’s first carbon-neutral continent by 2050. However, the achievement of these targets seems unlikely unless significant efforts are made by both governments and the private sector. In this context, the business world is expected to prioritize sustainable investments and adopt sustainable business models. Yet, the lack of a universally accepted definition of what constitutes sustainability in terms of activities, projects, and practices can create uncertainty around which investments are truly sustainable. The EU Taxonomy was introduced as a classification system to address this issue. It serves as a tool to determine which investments genuinely contribute to environmental goals in the fight against the climate crisis and can be considered sustainable. The Taxonomy is also crucial in creating a common framework for a low-carbon, sustainable business model, aligning with the European Green Deal roadmap, and establishing the first uniform standard for this transformation.
The need for the EU Taxonomy is also driven by increasing concerns over "greenwashing." As climate change awareness has surged, some companies have opted to claim their operations are already environmentally sustainable, rather than making real investments to reduce their environmental footprint. This practice, which seeks to create a false impression of eco-friendly efforts, has led to calls for stricter regulations. The Taxonomy is designed to tackle this issue by defining which economic activities can truly be considered environmentally sustainable, providing clarity for companies, investors, and policymakers, and preventing the exploitation of sustainability claims.
Published in the Official Journal of the European Union on June 22, 2020, and officially entering into force on July 12, 2020, the Taxonomy Regulation provides companies with a set of criteria based on six environmental objectives:[1]
Climate change mitigation
Climate change adaptation
The sustainable use and protection of water and marine resources
The transition to a circular economy
Pollution prevention and control
The protection and restoration of biodiversity and ecosystems
The EU Taxonomy Regulation aims to establish an environmental sustainability framework for the economic activities of both financial and non-financial companies. Companies seeking to align with the EU Taxonomy are expected to make significant contributions to one or more of the environmental objectives outlined above, while ensuring they do not cause harm to other environmental goals and comply with minimum safety standards. Furthermore, the Taxonomy Regulation asserts that the activities of three key stakeholder groups must align with sustainability principles:
Financial market participants, including investment funds, portfolio managers, and occupational pension providers, offering financial products in the EU,
Large companies already required to provide non-financial statements under the Non-Financial Reporting Directive (NFRD), and
The EU and Member States, responsible for establishing public measures, standards, or labels for green financial products or green bonds.[2]
The taxonomy is expected to be regularly reviewed and updated, featuring classifications based on various types of activities:
· Activities that make a significant contribution (such as renewable energy),
· Enabling activities (such as the production of renewable energy technologies),
· Transitional activities (those that, while still lacking low-carbon alternatives, align with the best practices in the sector, such as the best cement production in its class).
While the focus of the EU taxonomy is primarily on economic activities and large-scale financial institutions, it is crucial for non-financial organizations to closely monitor this classification as well. Non-financial companies may need to clarify how their economic metrics align with the taxonomy. Activities falling under the first two environmental objectives are expected to be disclosed by both financial and non-financial organizations starting from January 1, 2022, while activities related to the last four objectives will need to be disclosed from January 1, 2023.
The planned regulations aim to not only create a “green” classification but also introduce a more detailed structure that includes “brown or red” activities. With the inclusion of the brown criteria, the taxonomy is expected to establish three performance levels: significant contribution (green), serious harm (brown or red), and a middle category for activities that neither significantly contribute nor cause serious harm.[3]
How the Taxonomy Benefits Companies
As sustainability becomes a key driver of success, businesses are under growing pressure to embrace transparency and adopt eco-friendly practices. Companies that align with these principles stand to gain a significant edge in today’s competitive landscape. By adhering to the taxonomy framework, they can attract eco-conscious investors and strengthen their brand. In parallel, financial institutions looking to expand their portfolios of green investments will increasingly seek out these companies, creating a virtuous cycle of growth, reputation, and profitability.
Companies that evaluate their economic activities against the best practices outlined in the taxonomy will be able to better assess the impact they create and take steps for continuous improvement. This approach also helps manage potential legal and financial risks associated with their operations.
[1] https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en
[2] https://corpgov.law.harvard.edu/2020/06/10/the-ripple-effect-of-eu-taxonomy-for-sustainable-investments-in-u-s-financial-sector/
[3] https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/200309-sustainable-finance-teg-final-report-taxonomy_en.pdf